ChainWhat it assumes · how to break it
Start
The government invests in infrastructure, for example new rail links, roads, broadband and energy networks.
1
As a result, construction creates demand for materials and workers; the spending is an injection, so AD rises through the multiplier.
injection · multiplier
injection · multiplier
Assumes: There is spare capacity.
But: Near full capacity, construction costs and wages rise rather than output.
2
Once complete, journey times and business costs fall, for example through faster freight, more reliable energy and better broadband.
costs of production
costs of production
Assumes: The project is completed on time and on budget.
But: Large projects often overrun: HS2's costs rose sharply and its route was cut back, raising the opportunity cost.
3
This means firms become more productive and can reach more customers and workers, so LRAS shifts right.
LRAS · productivity
LRAS · productivity
Best link to attack
Assumes: The project is the right one.
Assumes: The project is the right one.
But: If the project is chosen for political reasons rather than economic return, the gain in productivity may be small compared with its cost.
4
Therefore, both actual output and potential output rise.
actual and potential growth
actual and potential growth
Assumes: Demand keeps pace with capacity.
But: If demand is weak, some of the new capacity goes unused.
End
Economic growth rises in both the short run and the long run.
Time lag: major projects take years, sometimes decades, to plan and build.
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Questions this answers
- Assess the impact of infrastructure spending on economic growth.
- Discuss whether large infrastructure projects are a good use of public money.
- Explain why infrastructure investment affects both AD and LRAS.
Diagram
AD/AS: AD shifts right in the short run; LRAS shifts right in the long run.
Reverse and related
Cuts to infrastructure investment → lower AD now and slower capacity growth later.